FCNR(B) Flows – What exactly did it achieve in the final analysis?

Did the FCNR(B) deposit scheme that was recently concluded by the RBI help to serve its purpose. The main FCNR(B) plan was not just about defending the rupee, but also giving banks access to a glut of liquidity.

Money did come in, but at a huge cost

To be fair, the money did come in. An inflow of $143 billion in just a couple of months is not a small amount for the Indian economy. However, it did come in at a fairly huge cost. Let us talk about the cost to banks. Banks will be paying an average interest cost of around 6.5%-6.7% on these deposits. In addition, there is the cost of hedging the interest portion. Put together, the banks will have to spend more than their average cost of deposits. Then, there is the cost to the RBI to hedge the deposits, which (at 3%) will add up to nearly $21 billion over 5 years. And most of these funds are leveraged.

It has made little difference to the rupee

That is the biggest concern. One of the main ideas behind the FCNR(B) scheme was to help build guardrails around the rupee. That has not happened. The inflow helped the rupee to temporarily surge to around ₹94/$. However, over the last one month, the USDINR is back to ₹97/$ and close to its all-time lows. This is in contrast to the situation in 2013, when the FCNR(B) inflows led to immediate strengthening of the rupee. The rupee, today, continues to face pressure in the NDF market and there is a huge liability for the banks and RBI to fulfil over the next 5 years. Ironically, the short dollar hedges built to defend the rupee has, in itself, become the reason for the rupee weakening.

Is it helping boost deposits and credit?

To be fair, the FCNR(B) flows have been responsible for the deposit growth of banks surging and reducing the gap with credit growth. However, this has come at the expense of CASA deposits and at a much higher cost. The higher cost of the FCNR(B) deposits is threatening to narrow the net interest margins (NIMs) of banks by up to 25 basis points. The one factor that has helped to give a boost to the NIMs is the rate hike by the RBI, which could have been done even without the FCNR(B) scheme. Also, the surge in deposits has capped the rate of interest paid on deposits and will still not help deposit growth in normal times. Also, these deposits have come at a huge cost.

Did it really boost the forex reserve position?

On paper, there was a surge in forex reserves after the FCNR(B) dollar inflows were swapped into rupees by the bank. However, in the last 3 weeks, we have seen that accretion winding down rapidly. For example, the FCNR(B) deluge had increased India’s forex reserves from $690 billion to $785 billion. However, over the next 3 weeks, persistent RBI intervention with dollar sales has already depleted $50 billion. Reserves are now down to $734 billion. On paper, the FCNR(B) scheme looks like an optical victory. One can argue that, but for the FCNR(B) inflows, the rupee would have already touched ₹100/$. Even if FCNR(B) was a victory, it does look like a Pyrrhic Victory!